A correction in the equity market over the past couple of weeks has not only raised investor concerns but also a debate on domestic economic fundamentals. Ritesh Jain, chief investment officer, BNP Paribas Mutual Fund, told Sandeep Singh in an interview that if companies’ earnings don’t catch up in some time, returns might fall short of expectations. He added that since a broad-based earnings growth is unlikely, diversified funds may not do too well and funds with concentrated portfolio focusing on growth areas of economy could be a better choice. Edited excerpts:
Equities have done well this year. Do you find comfort at the current levels?
Indians used to invest in fixed deposits, real estate, gold and lastly in equities. Currently, when real estate, gold and fixed income (deposits) are not giving attractive returns, the only place left to invest in is equities where past returns have been attractive and, hence, flows into mutual funds have been growing. However, if the fundamentals (companies’ earnings) don’t catch up in sometime, people may get disappointed as returns might fall short of expectations. So it is very important that fundamentals catch up for people to continue to make good return. I feel that some set of earnings would come in the next two quarters but it will not be broad-based and, hence, I am comfortable with a select set of companies for investing.
When do you see that happening?
From 2014 onwards, private sector investment has lagged. While consumption is growing, the problem is that households are getting leveraged and if earnings and jobs don’t grow, it will lead to stress. State governments are going for farm loan waiver which is good for equity markets in the short term as it leads to free money in the hands of consumers. Even the government spending will push public sector capex (capital expenditure). So, earnings growth will come but it won’t be broad-based. Ideally, consumption should also lead to investments but capacity utilisation remains low at around 70 per cent. For it to go up, everything has to do well.
Also, for earnings to come, some inflation is needed. Earnings is a function of volume growth rate and price growth rate. While volume growth is there, price growth rate is at a nascent stage but will catch up over the next two quarters.
Why do you say that if jobs don’t grow, there will be stress?
If the earnings don’t grow and loans & household consumption continues to grow through leveraging then in few years, it will lead to stress in household balance sheet. If private investments kick off, it’s fine because jobs will be safe and household earnings will also grow and they will be able to pay but if it doesn’t happen then there will be stress. The job cycle has to revive.
Is inflation a concern right now?
China is shutting down capacities and this is the country which gave deflation to the world few years ago. Now, if there is a supply constraint from China, it could lead to inflation. That is only one aspect. The domestic core inflation has also risen to 4.5-4.6 per cent though the capacity utilisation is around 70 per cent and the government is not spending much. If the government starts spending and China continues to cut down on capacity, core inflation could rise and market needs to discount this in its earning calculation.
How do you see markets to behave?
The equity market should do well after an impending correction that will clear out weak hands. Early stages of inflation are good for equity markets and bad for bonds. So, we expect the equity market to do well over the next one year. We are now starting to get inflation which is required for corporate earnings and, hence, bullish on market. It is the later stage of inflation (18-24 months) where there is some concern because if the inflation remains high, the input price increase can’t be passed on as output price increase. That is when earnings starts to contract along with inflation becoming more ingrained in the system.
Till now, earnings got compressed because inflation has not been there. Going forward, we may see earnings getting compressed because of higher inflation and that is not good (stagflation) and we believe this will be evident in 18-24 months from now.
So, what should investors do?
Since a broad-based earnings growth is unlikely, diversified funds might not do too well. In a normal growth cycle, all parts of economy do well but that is not the case now and we are seeing growth only in the targeted part of economy. So, funds with concentrated portfolio focusing on growth areas of economy may be a better choice.
Economic growth is getting more and more narrow and if I take a portfolio where I need to keep everything then I believe it may not work.
Do you see the interest rate cycle reversing then?
In my view, it has already started to reverse. The 10-year yield is over 6.6 per cent and has risen from 6.4 per cent. While the RBI (Reserve Bank of India) guides the direction of interest rates, it is the demand and supply of bonds that determines where the rates should go. Rate cut should have led to lower rates, but they haven’t. In fact, rates are higher than the time when the RBI cut rates. The 10-year bond has moved from 6.40 to 6.60 per cent and we believe they are headed higher despite hopes of rate cuts.
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